Morgan Stanley's Q2 Not Much To Write Home About

Son of Groucho via FlickrSome very interesting data points were disclosed in Morgan Stanley's just released 10Q. First, we learn that in the last quarter, the company which had "blow out" earnings, at least compared to expectations and Goldman, actually was not much to write home about by typical Wall Street standards, with a whopping 8 days of trading losses in Q2. Considering that most Wall Street firms had quarters in a row with no daily trading losses, this is, sadly, quite disappointing. (Granted, there is that >$200 million outlier. We would love to know just what the full amount of that one day profit was, which alas does not have a ceiling in the histogram)

Next, and more important, is that MS has disclosed it has a rather substantial $5 billion in gross exposure to the PIIGS, as well as another $3.5 billion in funding exposure to Europe. Considering that most European banks had already offloaded their PIIGS exposure, at least we now know who they were offloading risk to.

Country Exposure—Exposure to European Peripherals.

In connection with certain of its Institutional Securities business segment activities, the Company has exposure to European peripheral countries, which are defined as exposures in Greece, Ireland, Italy, Portugal and Spain. At June 30, 2011, gross funded exposure before the benefit of hedges was approximately $5 billion and net funded exposure after hedges was approximately $2 billion. Gross funded exposure includes obligations from sovereign governments, corporations, and financial institutions. In addition to the gross funded exposure, at June 30, 2011, the Company had European peripheral country exposure for overnight deposits with banks of approximately $2 billion and unfunded loans to corporations of approximately $1.5 billion.

Next, in terms of potential downgrades, which Morgan Stanley is now very much exposed to following the S&P action on Friday, we learn that the company may face up to a $1.4 billion margin call in the case of a two-notch downgrade.

The Company is required to pledge additional collateral to certain exchanges and clearing organizations in the event of a credit rating downgrade. At June 30, 2011, the increased collateral requirement at certain exchanges and clearing organizations was $178 million in the event of a one-notch downgrade of the Company's long-term credit rating. A total of $1,371 million of collateral is required in the event of a two-notch downgrade.

Lastly, from the risk factors we read that a US downgrade will likely not be beneficial to Morgan Stanley:

Concerns regarding downgrade of the U.S. credit rating and the sovereign debt crisis in Europe could have a material adverse effect on our business, financial condition and liquidity.

On August 5, 2011, Standard & Poor's lowered its long term sovereign credit rating on the United States of America from AAA to AA+. While U.S. lawmakers reached agreement to raise the federal debt ceiling on August 2, 2011, the downgrade reflected Standard & Poor's view that the fiscal consolidation plan within that agreement fell short of what would be necessary to stabilize the U.S. government's medium term debt dynamics.

This downgrade could have material adverse impacts on financial markets and economic conditions in the United States and throughout the world and, in turn, the market's anticipation of these impacts could have a material adverse effect on our business, financial condition and liquidity. In particular, it could disrupt payment systems, money markets, long-term or short-term fixed income markets, foreign exchange markets, commodities markets and equity markets and adversely affect the cost and availability of funding and certain impacts, such as increased spreads in money market and other short term rates, have been experienced already as the market anticipated the downgrade.

In addition, it could adversely affect our credit ratings, as well as those of our clients and/or counterparties and could require us to post additional collateral on loans collateralized by U.S. Treasury securities. Because of the unprecedented nature of negative credit rating actions with respect to U.S. government obligations, the ultimate impacts on global markets and our business, financial condition and liquidity are unpredictable and may not be immediately apparent.

In addition, global markets and economic conditions have been negatively impacted by the ability of certain European Union ("EU") member states to service their sovereign debt obligations. The continued uncertainty over the outcome of the EU governments' financial support programs and the possibility that other EU member states may experience similar financial troubles could further disrupt global markets. In particular, it has and could in the future disrupt equity markets and result in volatile bond yields on the sovereign debt of EU members.

These factors could have an adverse effect on our business, financial condition and liquidity. In particular, in connection with certain of our Institutional Securities business segment activities, we have exposure to European peripheral countries, which are defined as exposures in Greece, Ireland, Italy, Portugal and Spain. At June 30, 2011, gross funded exposure before the benefit of hedges to European peripheral countries was approximately $5 billion and net funded exposure after hedges was approximately $2 billion. Gross funded exposure includes obligations from sovereign governments, corporations, and financial institutions. In addition to the gross funded exposure, at June 30, 2011, the Company had European peripheral country exposure for overnight deposits with banks of approximately $2 billion and unfunded loans to corporations of approximately $1.5 billion.